The Cost of Ignorance: Reputational Mark-up in the Market for Tuscan Red Wines

This paper argues that imperfectly informed consumers use simple signals to identify the characteristics of wine. The geographical denomination and vintage of a wine as well as the characteristics of a particular wine will be considered here. However, the specific characteristics of a wine are difficult to ascertain ex ante given the enormous product variety. The reputation of a denomination will thus be an important guide for consumers when assessing individual wines. Denomination reputation is a function of average quality as revealed by the past performance of producers. The impact of past performance increases over time, since producers consider improved average quality to be an important factor in enhancing the price, but this necessitates monitoring of members in the denomination. The market and pricing of Tuscan red wines provide a natural experiment because there are a number of denominations of different age, each of which is typically undergoing a process of gradual increase in quality standards over time. Furthermore, Tuscan red wines are easily comparable because of great similarities in climate and choice of grape varieties, soil and exposure to sun etc. We show that new denominations have a lower average quality score and that price differentials between denominations are linked to differences in average quality, although consumers tend to exaggerate the quality gap between prestige denominations and new denominations. Thus, a producer in an old denomination benefits from a substantial mark-up relative to an equally good producer from a new denomination. Since ambitious producers in new denominations suffer from price ‘discrimination’ it can be expected that they will produce vineyard branded but denomination neutral wines, provided they can overcome the large fixed costs associated with that strategy. We show that denomination neutral wines do indeed have a stronger price-quality relationship than denomination specific wines.